The Risks of Risk Parity

Abstract

Risk parity is an asset allocation strategy designed so each asset class contributes equally to overall portfolio risk (as measured by volatility). While risk parity offers potential advantages, its success hinges on key assumptions and a favorable environment for bonds. Like the traditional asset allocation approach it seeks to supplant, risk parity demands a long-term perspective. Unlike the traditional approach, however, risk parity uses a narrow definition of risk and makes no consideration for a critical element in long-term investing: valuations.

Keywords: risk parity, asset allocation, portfolio risk, volatility, portfolio return

JEL Classification: G10, G11, G14, G20, G22, G23, G30, G31